(FORTUNE Magazine) – Time is running short for Alan Lacy. As Sears' performance has drifted from lackluster to lousy, it looks as though he may be another casualty of the toughest turnaround challenge in retailing. Sears' profits plunged 83% in the second quarter. Same-store sales, which have declined for three consecutive years, increased early this year but have dropped the past four months. Meanwhile Lacy pushed out Mark Cosby, the chief of Sears' full-line stores, in July. And the rumor mill is churning about other top-tier changes. What about Sears' stock? Down 22% this year, it's one of the worst performers in retail.

Many investors are wondering: Why is Lacy still in his job? A diligent, mild-mannered finance man, Lacy, 50, ably performed the first duty the board assigned him when it named him CEO in the fall of 2000: He lowered expenses and Sears' $28.5 billion debt by slashing 65,000 jobs (24% of the workforce) and selling the company's credit card business to Citigroup last year. Now that Sears is a pure retail company, says Lacy, "it's an execution game." But his cost-cutting strategy, which includes reducing cashiers and inventory, has made growth all the more difficult. One of Sears' "self-inflicted problems"--as Lacy calls many of its woes--is that it doesn't have enough apparel in its stores this year. "We overreacted to last year's inventory excesses," he admits.

While Lacy stumbles, the board shows mercy. He has a powerful advocate in director Michael Miles, his boss in the 1980s and '90s when Miles headed Kraft and then Philip Morris, and Lacy was his fast-rising financial strategist. Another lifeline for Lacy happens to be a stock-price chart, presented at every Sears board meeting, showing--amazingly--that Sears has outperformed the S&P since 2000 (by 42%, in fact, since he became CEO) and even done better than Wal-Mart, Home Depot, and Kohl's. "With dividends reinvested, if you'll allow me that," Lacy says.

Famously polite and deferential when he needs to be, Lacy also has a backer in Eddie Lampert, the billionaire investor who controls 14.6% of Sears. Lampert, whose ESL Investments owns 52.6% of Kmart (which he chairs), scored in June when Kmart announced it would sell 54 stores to Sears for as much as $621 million. Kmart stock spurted 5% that day. Some contend that Lacy overpaid for the stores, endearing himself to Lampert. "We clearly paid a premium price for these stores," says Lacy. "But they're worth a lot more to us than they are to Kmart." This deal--plus seven stores that Sears is buying from Wal-Mart--is the foundation of Lacy's expansion plan. Next year he expects to open 70 new off-the-mall Sears stores. It is the company's biggest square-footage increase ever and a serious attempt to catch up with the discounters (Wal-Mart, Target, Home Depot) that have leveraged their efficiencies, convenience, and low prices to steal Sears' mall shoppers. "We're trying to make up for the last 20 years of change in the retail industry," Lacy says. "Time is not our friend."

Indeed, Lacy has plenty to prove--and fast. He's looking outside for a new president of U.S. retail. Bear Stearns analyst Christine Augustine (who rates Sears stock "underperform") believes that it will take at least three to six months to fill the position and another year for the new exec to make meaningful contributions. "I think that's fair," says Lacy, who is overseeing retail operations himself in the interim. Some retail experts contend that unless Lacy steps aside, Sears won't attract the top merchant it needs. Rumored candidates include J.C. Penney's Vanessa Castagna (unlikely, since she's the lead candidate to replace CEO Allen Questrom next year) and Sears Canada CEO Mark Cohen (also unlikely, since that publicly traded entity, 54.3% owned by Sears, is struggling through its own turnaround). "The rumor mill these days is bizarre," says Lacy, shaking off all threats. "For better or for worse, I come to the office every day and give it my best shot," he says. Asked about the possibility that he'll be out of a job next year, he replies, "We have to perform." --Patricia Sellers